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LIKE "PLASTICS" in "The Graduate," the one word you needed to know in the markets' rebound in the past few months has been "reflation." And the one thing you had to avoid was U.S. Treasury securities while loading up on stocks, junk bonds and commodities.

With the Treasury setting off an avalanche of paper and the Federal Reserve committed to buy up the securities, it seemed a perfect formula for classic printing press-inflation by the government. That elicited a chorus of warnings around the globe ranging from German Chancellor Angela Merkel to the head of China's central bank to such widely respected observers (and friends of Barron's) as Roundtable member Marc Faber and James Grant, editor of Grant's Interest Rate Observer. To various degrees, these critics contended America was on the road to inflation.

But there are dissenting voices. Some say the inflation trade may have run its course for now. Others doubt that the deflationary can be so readily overcome by government actions.

On the former, Jefferies' equity strategists suggested taking some chips off the table after the recent run that has taken commodities and stocks on a spirited run since March. They worry government could try to curb "speculative commodity inflation" by raising margin requirements or otherwise limiting speculative limits to bolster consumers.

Meantime, Jefferies may be getting antsy about seeing some results from government stimulus given weakening employment and consumer deleveraging crimping final demand. With the recent high correlation between commodities and stocks, the strategists advised shifting to a neutral stance on equities until "the market presents a more compelling opportunity," which I infer to mean lower stock prices.

Meantime, as governments' reflation efforts were boosting risk assets such as commodities and equities, Treasuries were trashed. That lifted the yield on the 10-year benchmark note, to a peak of 4% last month from a hair over 2% at the beginning of the year. That was even with the Fed announcing plans in mid-March to purchase $300 billion of Treasuries, which temporarily cut the 10-year yield, to 2.50% to 3% in a flash, before reversing the drop and more.

In the past few weeks, the 10-year is back down, to around 3.50%, but sentiment towards Treasury remains bearish. The sheer supply of paper to fund trillion-dollar-plus deficit, at best causes indigestion in the market. At worst, the prospect of debt monetization raises fears of inflation.

Yet, could these concerns are misplaced? That's the question posed by Hugh Hendry, chief investment officer of Ecletica Asset Management in the U.K. And what if the economy stalls because the credit markets prematurely tighten monetary policy for the authorities?

Investors are spooked because the rise in government debt is visible, Hendry writes in comments to Eclectica's investors. Mortgage-backed securities exploded from $500 billion in 1996 to $3.2 trillion in 2003, yet no one bats an eye and house prices boom. Suggest a similar increase in Treasuries and the market frets about finding buyers for all the paper and possible inflation.

As a result of the back-up in Treasury yields, the decline in mortgage rates has been erased. That's even after the Fed's plans to buy up over $1 trillion in mortgage-backed securities issued by agencies such as
Fannie Mae
(ticker: FNM) and
Freddie Mac
(FRE.) This rising cost of credit raises the possibility that the economy will remain subdued, says Hendry.

Moreover, all that fiscal stimulus money being raised in the Treasury isn't even getting spent, as David Rosenberg of Gluskin Sheff points out. Americans are boosting their savings rate, to a 16-year high of 6.9% in May from 5.6% in April and 4.3% in March. That was a repeat of 2008, when stimulus checks were largely saved.

"It is very clear that not even the most aggressive monetary and fiscal policy since the 1930s is going to stop consumer spending in volume terms form rolling over in the second quarter," Rosenberg writes.

Hendry of Eclectica thinks 2009 could be a "Groundhog Day" rerun of last year, when commodities such as crude oil peaked in early July. After that, Treasuries became golden, spiking in price to lower their yields to 2% as risk assets crashed with collapse of Lehman and all that ensued.

Rosenberg looks for the 10-year to rally in price to bring its yield down to 2.5% by year-end. "The history of post-bubble credit collapses is that even when the initial recession ends, the recovery phase is fraught with fragility, double-dip risks and lingering deflation pressure."